What Is Deferment?
Deferment is a temporary postponement of payments on a loan or other financial obligation, a key concept within personal finance and debt management. During a deferment period, borrowers are typically not required to make principal payments, and in some cases, interest may not accrue, particularly on certain types of federal student loans. This allows individuals facing financial hardship or specific life events to pause their repayment obligations without immediately damaging their credit standing. The terms and conditions of deferment vary significantly depending on the type of loan and the lender's policies.
History and Origin
While the concept of postponing financial obligations has existed for centuries, formal deferment mechanisms became more widespread with the advent of standardized lending, particularly in the realm of student loan programs and housing finance. The federal student loan system, established throughout the latter half of the 20th century, incorporated deferment options to assist borrowers in specific circumstances, such as continuing education or military service.
Historically, the broader financial system has also seen forms of deferment or "regulatory forbearance" during periods of economic distress. For instance, during the Savings and Loan Crisis of the 1980s, regulators sometimes allowed insolvent thrifts to remain open rather than immediately closing them, a form of deferral in addressing financial instability, often exacerbating problems over time.4 These actions, while not direct borrower deferments, illustrate how the principle of postponing required actions can be applied at an institutional or systemic level during crises.
Key Takeaways
- Deferment temporarily suspends loan payments, providing relief during periods of financial strain or significant life events.
- Interest accrual during deferment depends on the loan type; it may be subsidized (no interest accrues) or unsubsidized (interest continues to accrue).
- Common reasons for deferment include enrollment in school, unemployment, military service, or economic hardship.
- Borrowers must typically apply for deferment and meet specific eligibility criteria set by their lender or loan servicer.
- While offering immediate relief, deferment can extend the overall loan term and potentially increase the total cost of the loan due to accrued interest.
Interpreting Deferment
Deferment serves as a crucial tool for borrowers to navigate temporary financial difficulties or life transitions without immediately defaulting on their obligations. When a deferment is granted, it means the lender has formally approved a pause in payments for a specified period. For borrowers of federal student loans, understanding whether their loan is subsidized or unsubsidized is critical, as this determines if interest will continue to accrue during the deferment period. For unsubsidized loans, accrued interest will typically be added to the principal balance at the end of the deferment, a process known as capitalization, increasing the total amount owed.
In the context of a mortgage, deferring payments means those missed payments are typically added to the end of the loan term or paid off when the property is sold or refinanced. This can help prevent delinquency or foreclosure for homeowners experiencing short-term financial distress.
Hypothetical Example
Consider Sarah, who has a federal unsubsidized student loan with an outstanding balance of $30,000 and a 6% annual interest rate. After graduating, she begins a new job but decides to pursue a master's degree part-time, enrolling at least half-time. She applies for and is granted an in-school deferment for 24 months.
- Initial Balance: $30,000
- Deferment Period: 24 months
- Interest Accrual: Since her loan is unsubsidized, interest continues to accrue at 6% annually. Monthly interest would be:
- Total Interest During Deferment: Over 24 months, the accrued interest is:
- New Loan Balance (after deferment): When her deferment ends, this accrued interest will be added to her principal balance:
Sarah's total loan balance has increased by $3,600, meaning her subsequent monthly repayment plan will be based on this higher amount, increasing the total cost of her loan over its lifetime.
Practical Applications
Deferment is widely used in several areas of finance and personal planning:
- Student Loans: This is one of the most common applications. Federal student loan borrowers may qualify for deferment due to enrollment in school at least half-time, unemployment, economic hardship, military service, or while undergoing cancer treatment.3 Private student loan lenders may also offer deferment options, though terms vary.
- Mortgage Loans: While less common than for student loans, mortgage servicers may offer payment deferrals, especially after a period of forbearance. This typically means that missed payments are added to the end of the loan term, or become a separate lien to be paid when the home is sold or refinanced, helping homeowners avoid foreclosure.2
- Retirement Planning: The term "deferral" is used for contributions to certain retirement plans, such as a 401(k) or 403(b). "Elective deferrals" refer to the portion of an employee's salary that is withheld and contributed to a retirement account before taxes, thereby deferring the taxation of that income until retirement. The IRS sets annual limits on these contributions.1
Limitations and Criticisms
While deferment provides crucial relief, it comes with limitations and potential drawbacks. The most significant criticism is the accrual of interest on unsubsidized loans or certain deferred payments. When interest accrues during a deferment and is then capitalized (added to the principal balance), it increases the total amount owed and the subsequent monthly payments. This can significantly raise the overall cost of the loan and extend the repayment period, potentially trapping borrowers in a cycle of growing debt.
Furthermore, deferment may not always count towards loan forgiveness programs or progress on income-driven repayment plans for federal student loans. Borrowers must actively manage their deferment periods, understand the terms, and track the end date to avoid accidentally falling into default once payments resume. Relying on deferment too frequently or for extended periods can ultimately undermine a borrower's long-term financial stability.
Deferment vs. Forbearance
Deferment and forbearance are both options for temporarily pausing loan payments, but they differ primarily in how interest accrues and the qualifying criteria. Deferment is typically available for specific, well-defined situations, such as active enrollment in higher education, military service, unemployment, or qualifying economic hardship. For many federal student loans, particularly subsidized ones, interest does not accrue during deferment, meaning the loan balance does not increase. In contrast, forbearance is generally granted for broader reasons of financial hardship at the discretion of the lender or servicer. With forbearance, interest almost always continues to accrue on all types of loans, including subsidized federal student loans. This accrued interest is then typically capitalized, increasing the principal balance. Borrowers should carefully consider the implications of interest accrual when choosing between deferment and forbearance.
FAQs
What types of loans can be deferred?
Deferment is most commonly associated with student loans, both federal and some private. It can also apply to certain mortgage payment arrangements or specific scenarios with other types of loans, and the concept of deferral applies to contributions to retirement plans like 401(k)s.
Does interest always accrue during deferment?
No, interest does not always accrue during deferment. For federal subsidized student loans, the government pays the interest during the deferment period. However, for unsubsidized federal student loans and most private loans, interest typically continues to accrue and may be added to your principal balance when the deferment ends.
How do I apply for deferment?
To apply for deferment, you typically need to contact your loan servicer. They will provide the necessary forms and explain the specific eligibility requirements and documentation needed for your situation. It is crucial to continue making payments until your deferment request is approved to avoid delinquency.
Can deferment impact loan forgiveness or repayment plans?
Yes, periods of deferment may not count toward the required payment periods for certain loan forgiveness programs, such as Public Service Loan Forgiveness (PSLF), or for progress on income-driven repayment plans. Borrowers pursuing these paths should verify how deferment will affect their eligibility.